Can wealth managers rise to the decumulation challenge
Can wealth managers rise to the decumulation challenge is a guest post by Danielle Levy aimed at wealth management clients.
The government’s decision to axe compulsory annuities marks a watershed moment, as ordinary people grasp the opportunity to take control of their hard-earned pension pots.
The pension freedoms, which came into force in April of this year, provide financial advisers and wealth managers with a fantastic opportunity to engage with those who are approaching or saving for retirement.
Receiving advice in preparation for this important stage is crucial, particularly if there is a much anticipated swing in the number of people who adopt a drawdown or decumulation investment strategy, rather than taking out an annuity. Drawdown means that you keep the majority of your pension pot invested and draw the income directly from the pension. This shift away from annuities has been dubbed the ‘democratisation of drawdown’.
However, as any Spider-Man fan will tell you: with great power comes great responsibility. Following the pension freedoms, wealth managers and financial advisers will come under even greater pressure to deliver for their clients during retirement.
Yet some question whether wealth managers who adopt a conventional investment approach, particularly those that have a stockbroker heritage, have the ability to deliver viable drawdown strategies that provide the all-important aspect of a sustainable income.
Complicating matters, numerous approaches can be adopted. The first type relies on a natural income stream generated by the portfolio and avoids taking money out of the capital base.
However, if the income generated disappoints, clients end up drawing down from the portfolio’s capital base. This can prove tricky during times of market stress because it forces you to crystallise losses.
The second approach involves running a large cash element (equating to two to three years’ worth of annual income) to avoid selling assets at depressed prices. This works for some, but can rely on replenishing the cash cushion, while the value of the cash portion is eroded over time.
Other firms adopt a volatility-focused multi-asset approach that uses derivatives to protect against downside risk.
There is little independent evidence that favours a certain strategy. Much will come down to the client and their preference.
Stuart Fowler of wealth manager Fowler Drew believes the industry lacks the wherewithal when it comes to decumulation because methodologies are ‘simply not fit for purpose’ .
‘We are talking about the equivalent in 2015 of an industry that is operating in 1973 – the year the Austin Allegro was produced. It is still viewed as the worst car ever built. We are not talking about the factory technologies that you might find in Honda in 2015,’ Fowler said.
In his opinion, investment approaches that focus on managing volatility can fall short because they do not address inflation risk, which can be more important for clients than volatility.
Bonds have historically lowered risk and smoothed return paths in drawdown strategies, but the asset class no longer plays the same role – which poses a challenge for investment managers.
Another potential hurdle is that the sustainability of a decumulation strategy needs to be in real rather than nominal terms, with comprehensive input from the client on their forecasted spending in retirement.
Fowler’s comments could be deemed over-cynical. Nevertheless, they are supported by a lack of published research on the subject of decumulation in comparison to accumulation.
Meanwhile, a chronic lack of investment in systems to support decumulation strategies serves as another significant challenge. From risk-profiling to cash flow modelling, a large portion of existing systems have been set up with an accumulation bias and need to be adjusted.
Further research dedicated to decumulation, alongside investment in systems must follow the pension freedoms, as wealth managers grapple with these new-found opportunities and responsibilities.
Danielle Levy is Deputy Editor at Citywire
She is responsible for setting the news agenda for Citywire Wealth Manager – a weekly magazine and website – and is a regular contributor to the Money pages for the Independent on Sunday.
Can wealth managers rise to the decumulation challenge is a guest post and the views here do not necessarily concur with those of Investment Quorum. In fact it is very often the case that we may be largely in disagreement but we respect the opinions and views of others and value their contribution to the debate. Guest posts may appeal more to some than others and may often have an industry or sector knowledge expectation.
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